Tesla TSLA will be included in the S&P 500 index starting December 21. The S&P 500 is an index, measuring the stock performance of 500 large firms. Although Tesla is large enough by market capitalization to warrant inclusion, its place on the list is a risk for the entire index. Market watchers dispute whether Tesla’s fundamentals warrant such a high value, and some believe its value is poised to eventually plummet. Others, though, think Tesla is unique.
Tesla’s market cap is around $400 billion. That far exceeds the market cap of traditional car manufacturers like GM (around $60 billion), Ford (around $35 billion) and Toyota (around $200 billion). Tesla has reached this level even though its revenue is under $30 billion. P/E ratio is astronomical when the company has earnings. Tesla’s positive cash flow relies on selling carbon credits. In other words, without a government-induced side market, Tesla would not be making money.
On the other hand, Tesla fans—some of whom are fanatical boosters like sports fans—say that its stock price is justified, because the company offers great potential. This may be true. Tesla is the leader in electric vehicles, both in terms of sales and in terms of branding. If the future of driving is with EVs, Tesla has a head start against its competitors. However, competitors exist and new competitors are always entering the market. General Motors is one of the major car companies with an existing EV program, and Ford wants to produce its own batteries. Nissan has been selling the Leaf electric car since 2010. Toyota offers an array of hybrids, and has for years. Furthermore, a range of EV startups is always preparing to compete, some of which include former Tesla employees. Tesla is not the only player on the field, and Tesla cannot even supply its own battery needs as of yet. It relies on Panasonic to supply the hearts of its vehicles. A long-term index investor in the S&P 500 has to consider whether the promise of Tesla is as great as a $400 billion market cap would indicate.
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The S&P 500 is vital for two reasons. One, it is an index in which people can invest, and index investing is huge right now. More importantly, the S&P 500 is one of three main gauges for the health of the U.S. stock market. The S&P 500 is weighted by market cap, so the biggest companies have the most influence on its movement. For example, Apple AAPL and Alphabet will influence the S&P 500 more than Tesla will. However, if EVs do not take off, or if the competition proves more formidable than expected, or if the luster just comes off of Tesla, its sky high market cap and P/E could prove trouble for the S&P 500 and the U.S. stock market as a whole.